UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
--------------
FORM 10 Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2000
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXHANGE ACT OF 1934
For the transition period from to
Commission File Number 0-21824
---------------------
HOLLYWOOD ENTERTAINMENT CORPORATION
(Exact name of registrant as specified in charter)
OREGON 93-0981138
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
9275 S.W. Peyton Lane, Wilsonville, Oregon 97070
(Address of principal executive office, including zip code)
(503) 570-1600
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such short period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
As of August 7, 2000 there were 46,221,530 shares of the registrant's Common
Stock outstanding.
<PAGE>
HOLLYWOOD ENTERTAINMENT CORPORATION
June 30, 2000
Page
PART I. FINANCIAL INFORMATION 3
Item 1. Financial Statements 3
Consolidated Statements of Operations 3
Consolidated Balance Sheets 4
Consolidated Statements of Cash Flows 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial 11
Condition and Results of Operations
PART II. OTHER INFORMATION 18
Item 6. Exhibits and Reports on Form 8-K 18
Signatures 19
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
<PAGE>
HOLLYWOOD ENTERTAINMENT CORPORATION
CONSOLIDATED STATEMENT OF OPERATIONS
(Unaudited)
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------------------------------
2000 1999 2000 1999
---------- ----------- ---------- -----------
<S> <C> <C> <C> <C>
Revenue:
Rental revenue $ 261,902 $ 205,628 $ 534,352 $ 426,943
Product sales 60,734 44,740 123,606 89,954
---------- ----------- ---------- -----------
322,636 250,368 657,958 516,897
Cost of sales:
Cost of rental 79,700 63,100 170,861 131,746
Cost of product 68,913 31,886 116,320 63,320
--------- ----------- ---------- -----------
148,613 94,986 287,181 195,066
--------- ----------- ---------- -----------
Gross margin 174,023 155,382 370,777 321,831
Operating costs and
expenses:
Operating and selling 161,804 120,465 324,687 241,158
General and
administrative 21,781 15,020 38,598 33,260
Restructuring charge
for closure of
internet business 48,548 48,548
Amortization of
intangibles 11,964 14,190 26,283 28,316
--------- ----------- --------- -----------
244,097 149,675 438,116 302,734
--------- ----------- --------- -----------
Income (loss) from
operations (70,074) 5,707 (67,339) 19,097
Non-operating income
(expense):
Interest income 102 66 102 73
Interest expense (15,547) (11,491) (29,617) (21,110)
--------- ------------ --------- -----------
Loss before income taxes (85,519) (5,718) (96,854) (1,940)
Benefit (provision) for
income taxes 22,475 (2,611) 21,647 (9,166)
--------- ------------ --------- -----------
Loss before cumulative
effect of a change in
accounting principle (63,044) (8,329) (75,207) (11,106)
Cumulative effect of a
change in Accounting
principle (net of income
tax benefit of $983) - - - (1,444)
--------- ----------- --------- ------------
Net loss $ (63,044) $ (8,329) $(75,207) $ (12,550)
========== =========== ========= ============
-------------------------------------------------------------------------------
Net loss per share before
cumulative effect of a
change in accounting
principle
Basic $ (1.37) $ (0.18) $ (1.63) $ (0.24)
Diluted $ (1.37) $ (0.18) $ (1.63) $ (0.24)
-------------------------------------------------------------------------------
Net loss per share:
Basic $ (1.37) $ (0.18) $ (1.63) $ (0.28)
Diluted $ (1.37) $ (0.18) $ (1.63) $ (0.28)
-------------------------------------------------------------------------------
Weighted average shares
outstanding:
Basic 46,141 45,612 46,074 45,412
Diluted 46,141 45,612 46,074 45,412
</TABLE>
The accompanying notes are an integral part of this financial statement
<PAGE>
HOLLYWOOD ENTERTAINMENT CORPORATION
CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
----------- ------------
(unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 4,371 $ 6,941
Receivables 38,785 42,679
Merchandise inventories 69,658 84,373
Income tax receivable 2,748 1,797
Prepaid expenses and other current assets 10,612 10,377
---------- -----------
Total current assets 126,174 146,167
Rental inventory, net 363,763 339,912
Property and equipment, net 400,679 382,345
Goodwill, net 104,570 145,504
Deferred income tax 77,623 52,691
Other assets, net 26,058 13,558
---------- ----------
$1,098,867 $1,080,177
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term obligations $ 115,993 $ 14,493
Accounts payable 115,703 111,578
Accrued expenses 78,725 64,566
Accrued revenue sharing 25,808 9,402
Accrued interest 10,162 11,865
---------- ----------
Total current liabilities 346,391 211,904
Long-term obligations, less current portion 472,570 519,413
Other liabilities 47,624 44,331
---------- ----------
866,585 775,648
---------- ----------
Shareholders' equity:
Preferred stock, 19,500,000 shares
authorized; no shares issued and
outstanding - -
Common stock, 100,000,000 shares
authorized; 46,170,259 and 45,821,537
shares issued and outstanding,
respectively 365,267 362,307
Retained deficit (132,985) (57,778)
---------- ----------
Total shareholders' equity 232,282 304,529
---------- ----------
$1,098,867 $1,080,177
========== ==========
</TABLE>
The accompanying notes are an integral part of this financial statement.
<PAGE>
<TABLE>
<CAPTION>
HOLLYWOOD ENTERTAINMENT CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
Six Months Ended
June 30,
------------------------------
2000 1999
------------ ----------
<S> <C> <C>
Operating activities:
Net loss $ (75,207) $ (12,550)
Adjustments to reconcile net loss to cash
provided by operating activities:
Cumulative effect of a change in accounting
principle - 1,444
Depreciation and amortization 118,485 110,017
Amortization of deferred financing costs 1,256 846
Change in deferred rent 1,349 1,524
Change in deferred income taxes (22,988) (229)
Net asset write down for closure of internet
business 40,087 -
Net change in operating assets and liabilities:
Receivables 3,725 805
Merchandise inventories 1,261 1,264
Accounts payable 4,125 (42,202) 1,264
Accrued interest (1,703) (719)
Accrued revenue sharing 16,406 (5,216)
Other current assets and liabilities 14,194 5,887
----------- -----------
Cash provided by operating activities 100,990 60,871
----------- -----------
Investing activities:
Purchases of rental inventory, net (89,176) (82,885)
Purchases of property and equipment, net (55,737) (45,472)
Investment in businesses acquired - (14,072)
Increase in intangibles and other assets (13,976) (3,652)
----------- -----------
Cash used in investing activities (158,889) (146,081)
----------- -----------
Financing activities:
Issuance of long-term obligations 12,511 56,800
Repayments of long-term obligations (6,854) (6,912)
Tax benefit from exercise of stock options 54 3,461
Proceeds from exercise of stock options 618 4,034
Increase in revolving loan, net 49,000 30,000
----------- -----------
Cash provided by financing activities 55,329 87,383
----------- -----------
Increase (decrease) in cash and cash
equivalents (2,570) 2,173
Cash and cash equivalents at beginning
of year 6,941 3,975
----------- -----------
Cash and cash equivalents at end of the second
quarter $ 4,371 $ 6,148
=========== ===========
Non-cash financing activities
Issuance of common stock as part of a legal
settlement agreement $ 2,288 -
</TABLE>
The accompanying notes are an integral part of this financial statement.
<PAGE>
HOLLYWOOD ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The unaudited consolidated financial statements have been prepared pursuant to
the rules and regulations of the Securities and Exchange Commission. Certain
information and note disclosures normally included in annual financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to those rules and regulations,
although the Company believes that the disclosures made are adequate to make
the information presented not misleading. The information furnished reflects
all adjustments which are, in the opinion of management, necessary for a fair
statement of the results for the interim periods presented, and which are of a
normal, recurring nature. These financial statements should be read in
conjunction with the financial statements and the notes thereto included in the
Company's annual report on Form 10-K for the year ended December 31, 1999,
filed with the Securities and Exchange Commission.
(1) Accounting Policies
The consolidated financial statements included herein have been prepared in
accordance with the accounting policies described in Note 1 to the December
31, 1999 audited consolidated financial statements included in the
Company's annual report on Form 10-K. Certain prior year amounts have been
reclassified to conform to the presentation used for the current year.
These reclassifications had no impact to previously reported net loss or
shareholders' equity.
(2) Statements of Changes in Shareholders' Equity
An analysis of the shareholders' equity amounts for the two quarters ended
June 30, 2000 is as follows:
<TABLE>
<CAPTION>
Common Stock
------------------------
(In thousands, except share amounts) Shares Amount
----------- ----------
<S> <C> <C>
Balance at December 31, 1999 45,821,537 $ 362,307
Issuance of common stock under option plan 148,722 618
Tax benefit from exercise of stock options 54
Issuance of common stock as a part of legal
Settlement agreement 200,000 2,288
Net loss ----------- -----------
Balance at June 30, 1999 46,170,259 $ 365,267
=========== ===========
-------------------------
Retained
Deficit Total
----------- ----------
Balance at December 31, 1999 $ (57,778) $ 304,529
Issuance of common stock under option plan 618
Tax benefit from exercise of stock options 54
Issuance of common stock as part of a legal
Settlement agreement 2,288
Net loss (75,207) (75,207)
----------- ----------
Balance at June 30, 1999 $ (132,985) $ 232,282
=========== ==========
</TABLE>
(3) Operating Leases
The Company leases all of its stores, corporate offices, distribution
centers and zone offices under non-cancelable operating leases. All of the
Company's stores have an initial operating lease term of five to fifteen
years and most have options to renew for between five and fifteen
additional years. Most operating leases require payment of property taxes,
utilities, common area maintenance and insurance. Total rent expense,
including related lease-required cost was $60.7 million and $119.3 million
for the current year second quarter and two quarters, respectively,
compared with $48.6 million and $95.7 million for the corresponding periods
of the prior year.
(4) Earnings per Share
Basic earnings per share are calculated based on income available to common
shareholders and the weighted-average number of common shares outstanding
during the reported period. Diluted earnings per share includes additional
dilution from the effect of potential issuances of common stock, such as
stock issuable pursuant to the exercise of stock options, warrants
outstanding and the conversion of debt.
The following table is a reconciliation of the basic and diluted earnings
per share computations:
<TABLE>
<CAPTION>
Six Months Ended
June 30,
(In thousands, except per share amounts)
-----------------------------------------------------------
2000 1999
-----------------------------------------------------------
Per Per
Share Share
Loss Shares Amounts Income Shares Amounts
--------- ------- --------- --------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
Basic loss per share: $(75,207) 46,074 $ (1.63) $(12,550) 45,412 $(0.28)
Effect of dilutive
securities:
stock options - - - -
--------- ------- --------- -------
Diluted loss per share: $(75,207) 46,074 $ (1.63) $(12,550) 45,412 $(0.28)
========= ======= ========= ========= ======= =======
</TABLE>
Due to the Company's net loss, stock options accounted for using the treasury
stock method would be antidilutive. Accordingly, 0.4 million shares and 2.6
million shares have been excluded from the diluted net loss per share
calculation for the six months ended June 30, 2000 and 1999, respectively.
(5) Store Preopening Cost
In April 1998, SOP 98-5, "Reporting on the Cost of Start-up Activities,"
was finalized, which required that cost incurred for start-up activities,
such as store openings, be expensed as incurred. The Company adopted SOP
98-5 effective January 1, 1999. The cumulative effect of the change was to
increase net loss in the first quarter of 1999 by $1.4 million, net of tax
benefit.
(6) Segment Reporting
In June 1997, the Financial Accounting Standards Board (FASB) issued
Statement No. 131, "Disclosures about Segments of an Enterprise and Related
Information," effective for fiscal years beginning after December 15, 1997.
The Company adopted Statement No. 131 in 1998.
The Company identifies its segments based on management responsibility.
The Company operated two segments during the current year second quarter
and two quarters, the Hollywood Video segment, which consists of the
Company's 1,772 retail stores located in 47 states, and the Reel.com
segment, primarily an e-commerce company specializing in movies.
During the second quarter, the Company announced the discontinuation of e-
commerce operations at Reel.com. This resulted in a restructuring charge
detailed below in Note 7. All assets of Reel.com have been transferred to
the Hollywood Video segment as of the balance sheet date. The Company
measures segment profit as operating profit, which is defined as income
(loss) before interest expense and income taxes. Information on segments
and a reconciliation to income (loss) before income taxes are as follows (in
thousands):
<TABLE>
<CAPTION>
Three Months Ended Three Months Ended
June 30, 2000 June 30, 1999
-------------------------------------------------------------
Hollywood Hollywood
Video Reel.com Total Video Reel.com Total
--------- -------- --------- --------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Revenue $ 310,657 $ 11,979 $ 322,636 $ 241,977 $ 8,391 $250,368
Tape amortization 28,841 - 28,841 26,961 353 27,314
Other depreciation
and amortization 20,034 10,489 30,523 16,059 12,442 28,501
Operating income
(loss)* 24,266 (94,340) (70,074) 26,332 (20,625) 5,707
Interest expense,
net 13,342 2,103 15,445 10,534 891 11,425
Total assets 1,098,867 - 1,098,867 905,376 71,372 976,748
Purchases of
property and
equipment, net 25,065 207 25,272 19,607 1,446 21,053
</TABLE>
* Reel.com's operating loss includes a restructuring charge of $69.3 million
for discontinued e-commerce operations. The loss also includes $10.2 million
in goodwill amortization. Excluding the restructuring charge and goodwill
amortization, Reel.com's operating loss would have been $14.9 million and
$8.1 million for the three months ended June 30, 2000 and June 30, 1999
respectively.
<TABLE>
<CAPTION>
Three Months Ended Three Months Ended
June 30, 2000 June 30, 1999
-------------------------------------------------------------
Hollywood Hollywood
Video Reel.com Total Video Reel.com Total
---------- --------- --------- -------- -------- -------
<S> <C> <C> <C> <C> <C> <C>
Revenue $ 631,678 $ 26,280 $ 657,958 $502,151 $14,746 $516,897
Tape amortization 57,888 110 57,998 54,437 471 54,908
Other depreciation
and amortization 38,251 23,492 61,743 30,869 25,086 55,955
Operating income
(loss) * 55,430 (122,769) (67,339) 60,323 (41,226) 19,097
Interest expense,
net 25,249 4,266 29,515 19,579 1,458 21,037
Total assets 1,098,867 - 1,098,867 905,376 71,372 976,748
Purchases of
property and
equipment, net 54,219 1,518 55,737 43,383 2,089 45,472
</TABLE>
* Reel.com's operating loss includes a restructuring charge of $69.3 million
for discontinued e-commerce operations. The loss also includes $22.7 in
goodwill amortization. Excluding the restructuring charge and goodwill
amortization, Reel.com's operating loss would have been $30.8 million and
$16.1 million for the six months ended June 30, 2000 and June 30, 1999
respectively.
(7) Reel.com Discontinued E-commerce Operations
On June 12, 2000, the Company announced that it would close down the e-commerce
business at Reel.com. The Company developed a leading web-site over the seven
quarters since Reel.com was purchased in October of 1998, but their business
model of rapid customer acquisition led to large operating losses and required
significant cash funding. Due to market conditions, the Company was unable to
obtain outside financing for Reel.com, and could not justify continued funding
from its video store cash flow. On June 13, 2000, the Company terminated
employment of approximately 200 of Reel.com's 240 employees, and paid $1.9
million in involuntary termination benefits. The remaining employees have since
been terminated or integrated into Hollywood Entertainment.
The Company plans to maintain the web-site as a content-only site to minimize
any negative effect the Reel.com shutdown may have on existing Hollywood Video
store customers for a period of time not expected to exceed twelve months.
During this time, point of purchase materials promoting Reel.com as an
e-commerce destination will need to be removed from the stores. To offset the
costs of maintaining the web-site during this period, the Company has entered
into an agreement with Buy.com to direct Reel.com visitors to Buy.com to make
purchases. Revenues associated with the Buy.com agreement and the expenses of
maintaining the web-site will be recognized as earned and incurred,
respectively, in future financial statements.
As a result of the discontinuation of e-commerce operations, the Company
recorded a total charge of $69.3 million, of which $48.5 million is classified
as a restructuring charge on the consolidated statement of operations and $20.8
million is included in cost of product sales.
The restructuring charge line item includes $1.9 million of severance and
benefits paid on June 13, 2000, $19.3 million of asset write downs, and $27.3
million of accrued liabilities. The assets written down include the remaining
$14.9 million of goodwill associated with the acquisition of Reel.com, and $4.4
million to write down equipment, leasehold improvements, prepaid expenses and
accounts receivable to their net realizable values. Amounts accrued include
$21.5 million for contractual obligations, including lease commitments and
anticipated legal claims against the Company, and $5.8 million for legal,
financial, and other professional services incurred as a direct result of the
closure of Reel.com.
The Company plans to use some of the equipment from Reel.com at the new
distribution center in Nashville, Tennessee, and at the corporate offices in
Wilsonville, Oregon. Equipment not utilized by the Company will be sold.
Proceeds of approximately $250,000 are anticipated in the current year third
quarter.
Most of Reel.com's business agreements have been terminated under the
provisions of each agreement. Many of these agreements contain minimum
guarantee provisions, some of which can not be waived by terminating the
agreement. The Company anticipates paying approximately $5 million of the
$21.5 million total accrual by the end of the current year fourth quarter
with the remaining amount paid some time in 2001.
Charged to cost of goods sold was the write down of Reel.com inventory,
primarily DVD's, to net realizable value. This represents excess product for
the Hollywood Video segment as the stores are currently fully stocked for
both rental and sell through. The Company plans to liquidate this inventory
over the next year through special tent sales or sidewalk sales at select
stores, grand opening promotions, and outlet centers.
(8) Related Party Transactions
On May 8, 2000, the Board of Directors approved a long-term compensation
package for the Company's Chief Executive Officer, which included a $15 million
loan. The five year loan shall bear interest at an annual rate equal to the
greater of ten percent or the minium rate required under the Internal Revenue
Code and regulations for loans to affiliated persons, and is due in five
annual installments of $3 million beginning on June 1, 2001.
<PAGE>
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
Summary Results of Operations
The Company's net loss in the current year second quarter and two quarters was
$63 million and $75.2 million, respectively, compared with a net loss before
cumulative effect of a change in accounting principle of $8.3 million and $11.1
million for the corresponding periods of the prior year. The increase in net
loss was primarily due to a restructuring charge for discontinued e-commerce
operations of Reel.com
The following table sets forth (i) selected results of operations data,
expressed as a percentage of total revenue; (ii) other financial data; and
(iii) selected operating data.
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
----------------------------------------
2000 1999 2000 1999
-------- ------- -------- --------
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
Revenue:
Rental revenue 81.2% 82.1% 81.2% 82.6%
Product sales 18.8 17.9 18.8 17.4
------- ------- -------- --------
100.0 100.0 100.0 100.0
------- ------- -------- --------
Gross margin 53.9 62.1 56.4 62.3
Operating costs and expenses:
Operating and selling 50.1 48.1 49.3 46.7
General and administrative 6.8 6.0 5.9 6.3
Restructuring charge for closure of
internet business 15.0 - 7.4 -
Amortization of intangibles 3.7 5.7 4.0 5.5
------- ------- -------- -------
75.6 59.8 66.6 58.5
------- ------- -------- -------
Income (loss) from operations (21.7) 2.3 (10.2) 3.8
Non-operating income (expense), net (4.8) (4.6) (4.5) (4.1)
------- ------- -------- -------
Loss before income taxes (26.5) (2.3) (14.7) (0.3)
Provision for income taxes 7.0 (1.0) 3.3 (1.8)
Loss before cumulative effect
of a change in accounting principle (19.5) (3.3) (11.4) (2.1)
Cumulative effect of a change in
accounting principle - - - (0.3)
-------- ------- -------- --------
Net loss (19.5)% (3.3)% (11.4)% (2.4)%
-------- ------- -------- --------
--------------------------------------------------------------------------------
Other financial data:
Rental gross margin (1) 69.6% 69.3% 68.0% 69.1%
Product gross margin (2) (13.5)% 28.7% 5.9% 29.6%
--------------------------------------------------------------------------------
EBITDA (3) (In thousands)
Hollywood Video segment EBITDA $ 72,470 $ 68,660 $ 150,310 $ 143,119
Reconciliation to Adjusted EBITDA (4)
Add special charges (5) - - - 1,444
Add non-cash expenses 17,618 11,758 35,095 23,678
Less existing store investment in
new release inventory (46,614) (25,856) (82,936) (63,614)
--------- -------- --------- --------
Adjusted EBITDA Hollywood Video 43,474 54,562 102,469 104,627
Reel.com segment EBITDA (6) (14,518) (7,610) (29,834) (15,449)
--------- -------- --------- ---------
Consolidated Adjusted EBITDA $ 28,956 $ 46,952 $ 72,635 $ 89,178
--------------------------------------------------------------------------------
Cash flow from: (In thousands)
Operating activities $ 80,916 $ 23,163 $ 100,990 $ 60,871
Investing activities (89,599) (60,974) (158,889) (146,081)
Financing activities 8,651 39,275 55,329 87,383
-------------------------------------------------------------------------------
Operating data:
Number of stores at quarter end 1,772 1,403 1,772 1,403
Weighted average stores open during
the period 1,736 1,353 1,700 1,324
Comparable store revenue increase (7) 7% 18% 5% 18%
-------------------------------------------------------------------------------
</TABLE>
(1) Rental gross margin as a percentage of rental revenue.
(2) Product gross margin as a percentage of product revenue.
(3) EBITDA consists of operating income before interest, tax, depreciation and
amortization. EBITDA should not be viewed as a measure of financial
performance under Generally Accepted Accounting Principles (GAAP) or as a
substitute for GAAP measurements such as net income or cash flow from
operations. This calculation of EBITDA is not necessarily comparable to
reported EBITDA of other companies due to the lack of a uniform definition of
EBITDA.
(4) Adjusted EBITDA represents income from operations before depreciation and
amortization plus non-cash expenses that reduce EBITDA, less the cost of
acquiring new release rental inventory which is capitalized. Adjusted EBITDA
should not be viewed as a measure of financial performance under GAAP and
should not be considered as an alternative to cash flows from operating
activities (as determined in accordance with GAAP) as a measure of liquidity.
Our calculation of adjusted EBITDA is not necessarily comparable to amounts
reported by other companies due to the lack of a uniform definition of
EBITDA.
(5) The special charge relates to the cumulative effect of a change in
accounting principle resulting from the adoption of SOP 98-5.
(6) Excludes the restructuring charge of $69.3 million for the discontinuation
of e-commerce operations.
(7) A store is comparable after it has been open and owned by the Company for
12 full months. An acquired store converted to the Hollywood Video name and
store design is removed from the comparable store base when the conversion
process is initiated and returned 12 full months after reopening.
REVENUE
Revenue increased by $72.3 million, or 29%, in the current year second quarter
and $141.1 million, or 27%, in the current year two quarters compared with the
corresponding periods of the prior year. The increase was primarily due to the
addition of 369 new superstores in the twelve months ended June 30, 2000. An
increase in comparable store revenue of 7% and 5% in the current year second
quarter and two quarters, respectively, also favorably impacted revenue.
GROSS MARGIN
Rental margin as a percentage of rental revenue remained fairly consistent in
the current year second quarter compared to the corresponding period of the
prior year, respectively at 69.6% and 69.3%. The current year two quarters
rental margin decreased to 68.0% from 69.1% in the corresponding period of the
prior year. For the current year two quarters, the decrease in margin primarily
relates to a decrease in new release videocassettes purchased at sell through
pricing. Prior to revenue sharing, studios had two primary options for pricing
new release titles. The first, rental pricing, was to price each cassette at
approximately $65 and focus sales to video rental outlets. The second, sell
through pricing, was to price each cassette under $20 and sell to all
distributors of videocassette movies. The biggest hits each year were priced
for sell through and generally came with a substantial marketing push from the
studio. The low unit price, and studio advertising, made these types of
purchases the Company's best performers in terms of margin, including revenue
sharing purchases. Over the last two years, as revenue sharing has gained
acceptance, the percentage of titles released at sell through pricing has
substantially decreased.
Product margin as a percentage of product sales was a negative 13.5% and a
positive 5.9% in the current year second quarter and two quarters compared to
28.7% and 29.6% in the corresponding periods of the prior year. The negative
margin in the current year second quarter and low margin in the current year
two quarters was caused by a $20.8 million write down of inventory associated
with the restructuring of Reel.com. Excluding the inventory write down, product
margins were to 20.8% and 22.7% in the current year second quarter and two
quarters, respectively. The Company's gross margin on product sales has been
affected by an increase in the percentage of sales from previously viewed
movies and an increase in the percentage of sales from Reel.com which sold
product at a significantly lower margin than the Hollywood Video stores. The
average sales price of previously viewed movies has declined in recent quarters
as copy depth programs across the industry have greatly increased the supply.
OPERATING COSTS AND EXPENSES
Operating and Selling
Total operating expenses for the current year second quarter and two quarters
increased by $41 million and $84 million, respectively, when compared to the
prior year corresponding periods. Operating and selling expenses increased as
a percentage of total revenue to 50% and 49% in the current year second quarter
and two quarters compared to 48% and 47% in the corresponding periods of 1999.
The percentage increase is primarily due to an increase in advertising. For the
current year second quarter, the increase in total operating expenses resulted
from an increase in store labor cost of $14 million, occupancy costs of $12
million, other store operating expenses of $9 million and an increase in
Reel.com operating costs of $6 million. For the current year two quarters, the
increase in total operating expenses resulted from an increase in store labor
cost of $26 million, occupancy costs of $23 million, other store operating
expenses of $19 million and an increase in Reel.com operating costs of $16
million. With the exception of Reel.com, operating expenses increased due to
the growth in the number of superstores operated by the Company.
General and Administrative
General and administrative expenses in the current year second quarter and two
quarters increased by $7 million and $5 million to $22 million and $38 million,
respectively, from $15 million and $33 million in the prior year corresponding
periods. The increase was primarily due to higher payroll and related costs.
Restructuring Charge for Closure of Internet Business
On June 12, 2000, the Company announced that it would close down the e-commerce
business at Reel.com. The Company developed a leading web-site over the seven
quarters since Reel.com was purchased in October of 1998, but their business
model of rapid customer acquisition led to large operating losses and required
significant cash funding. Due to market conditions, the Company was unable to
obtain outside financing for Reel.com, and could not justify continued funding
from its video store cash flow.
The Company plans to maintain the web-site as a content-only site to minimize
any negative effect the Reel.com shutdown may have on existing Hollywood Video
store customers for a period of time not expected to exceed twelve months.
During this time, point of purchase materials promoting Reel.com as an
e-commerce destination will need to be removed from the stores. To offset the
costs of maintaining the web-site during this period, the Company has entered
into an agreement with Buy.com to direct Reel.com visitors to Buy.com to make
purchases. Revenues associated with the Buy.com agreement and the expenses of
maintaining the web-site will be recognized as earned and incurred,
respectively, in future financial statements. These revenues and expenses
should not have a material impact on income from operations, as any net
difference will be absorbed into the Company's existing marketing budget.
The restructuring charge of $48.5 million includes $1.9 million of severance
and benefits paid on June 13, 2000, $19.3 million of asset write downs, and
$27.3 million of accrued liabilities. The assets written down include the
remaining $14.9 million of goodwill associated with the acquisition of
Reel.com, and $4.4 million to write down equipment, leasehold improvements,
prepaid expenses and accounts receivable to their net realizable values.
Amounts accrued include $21.5 million for contractual obligations, including
lease commitments and anticipated legal claims against the Company, and $5.8
million for legal, financial, and other professional services incurred as a
direct result of the closure of Reel.com.
The Company plans to use some of the equipment from Reel.com at the new
distribution center in Nashville, Tennessee, and at the corporate offices in
Wilsonville, Oregon. Equipment not utilized by the Company will be sold.
Proceeds of approximately $250,000 are anticipated in the current year third
quarter.
Most of Reel.com's business agreements have been terminated under the
provisions of each agreement. Many of these agreements contain minimum
guarantee provisions, some of which can not be waived by terminating the
agreement. The Company anticipates paying approximately $5 million of the
$21.5 million total accrual by the end of the current year fourth quarter
with the remaining amount paid some time in 2001.
Amortization of Intangibles
Amortization of intangibles decreased to $12 million and $26 million in the
current year second quarter and two quarters from $14 million and $28 million
in the corresponding periods of the prior year. The decrease was caused by a
write down of Reel.com's goodwill as e-commerce operations discontinued in mid
June. The goodwill write down of $14.9 million was included in the
restructuring charge for closure of Internet business line item on the
Company's consolidated statement of operations.
NONOPERATING INCOME (EXPENSE), NET
Interest expense, net of interest income increased by $4 million and $8.5
million in the second quarter and current year two quarters compared to the
corresponding periods of the prior year due to increased levels of borrowings
under the Company's revolving credit facility.
INCOME TAXES
The Company's effective tax rate was a benefit of 26.3% and 22.4% in the
current year second quarter and current year two quarters, respectively,
compared to a provision of 45.6% and 472.5% for the corresponding periods in
the prior year. The significant decrease is due to the Company's net loss for
financial reporting purposes. The prior year second quarter provision was
primarily caused by the non-deductibility of goodwill amortization associated
with the Reel.com acquisition.
LIQUIDITY AND CAPITAL RESOURCES
The amount of cash generated from operations in the current year first quarter
significantly exceeded the current debt service requirements of the Company's
long-term obligations. The capital expenditures (including purchases of rental
inventory) of the Company are primarily funded by the excess operating cash
flow and through loans under a revolving line of credit.
At June 30, 2000, the Company had cash and cash equivalents of $4.4 million and
a working capital deficit of $220 million. Rental inventories are accounted for
as non-current assets under generally accepted accounting principles because
they are not assets which are reasonably expected to be completely realized in
cash or sold in the normal business cycle. Although the rental of this
inventory generates a substantial portion of the Company's revenue, the
classification of these assets as non-current excludes them from the
computation of working capital. The acquisition cost of rental inventories,
however, is reported as a current liability until paid and, accordingly,
included in the computation of working capital. Consequently, the Company
believes working capital is not as significant a measure of financial condition
for companies in the video retail industry as it is for companies in other
industries. Because of the accounting treatment of rental inventory as a non-
current asset, the Company may, from time to time, operate with a working
capital deficit.
Cash Provided by Operating Activities
Net cash provided by operating activities increased by $40.1 million in the
current year two quarters compared with the corresponding period of the prior
year. This increase was primarily due to an increase in accounts payable and
accrued liabilities, which are considered sources of operating cash.
Cash Used in Investing Activities
Net cash used in investing activities increased by $12.5 million in the current
year two quarters compared with the corresponding period of the prior year.
The increase was primarily due to a higher reinvestment of revenue in new
release movies and an increase in other assets.
Cash Provided by Financing Activities
Net cash provided by financing activities decreased by $32 million in the
current year two quarters compared with the corresponding period of the prior
year. The decrease was primarily due to a decrease in the issuance of long-
term obligations as the Company begins to fund growth through operating cash
flow instead of debt financing. The Company has the availability of up to $300
million in revolving credit loans. The Company may utilize the revolving
credit facility as needed for working capital, capital expenditures and general
corporate purposes. The total commitment under this facility will begin its
scheduled reduction of $37.5 million per quarter beginning in December, 2000
which continues until the revolving credit facility's maturity in September
2002. The Company expects to meet scheduled commitment reductions through debt
pay-down from internally generated cash flow from operations and a slowdown in
capital expenditures and investing activities. The Company may seek additional
financing as a source of incremental liquidity as necessary. As of June 30,
2000, $289 million was outstanding under the revolving credit agreement.
Capital Expenditures
The Company's capital expenditures include product for stores, store equipment
and fixtures, remodeling a certain number of existing stores, implementing and
upgrading office, warehouse and store technology and opening for new store
locations. Each new store opening requires initial capital expenditures,
including leasehold improvements, inventory, equipment and costs related to
site location, lease negotiations and construction permits. We currently
anticipate that capital expenditures based on opening 215 stores to be
approximately $110 million in 2000, of which $95 million is anticipated to
relate to new, relocated, remodeled stores and game departments. The remaining
balance relates to corporate capital expenditures. We expect the total
investment per new store to approximate $420,000, which includes rental and
merchandise inventory, leasehold improvement, signage, furniture, fixtures and
equipment. However, the cost of opening a new store can vary based on size,
construction costs in a particular market, and other factors. These capital
expenditures will be funded primarily by cash generated by operations,
supplemented by the availability of the senior revolving line of credit or
other forms of equipment financing and/or leasing if necessary. The Company
expects to open between 100 and 200 stores in 2001, based upon the availability
of capital resources coupled with the Company's desire to reduce outstanding
indebtness.
Year 2000 Compliance
The Year 2000 Issue is the result of computer programs being written using two
digits rather than four to define the applicable year. Computer programs that
have date sensitive software may recognize a date using "00" as the year 1900
rather than year 2000. To be in "Year 2000 compliance" a computer program must
be written using four digits to define years. As a result, computer systems
and/or software used by many companies may have required upgrading to comply
with such "Year 2000" ("Y2K") requirements.
The century rollover to January 1, 2000 went well for the Company. All
mission-critical systems performed as anticipated. The thousands of programs
and applications that had been remediated continued to function without
interruption or failure as we moved into the Year 2000.
Hollywood continues to monitor date-related systems matters. Based upon the
performance of our programs, applications, and systems to date, we believe that
Y2K issues are no longer of any material concern to the Company and its
business. The cost of the Y2K effort was approximately $1.2 million.
<PAGE>
PART II OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibit 27.1 Financial data schedule (electronic filing only)
(b) Reports on Form 8-K.
On June 15, 2000 the Company filed a current Report on Form 8-K stating
under "Item 5. Other Events" that the Company would close the e-commerce
business at Reel.com, Inc. On the same filing, also under "Item 5. Other
Events" the Company announced that it had retained the investment
banking firm Donaldson, Lufkin & Jenrette to explore strategic
opportunities to enhance shareholder value.
<PAGE>
HOLLYWOOD ENTERTAINMENT CORPORATION
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HOLLYWOOD ENTERTAINMENT CORPORATION
_____________________________________________
(Registrant)
August 14, 2000 /S/David G. Martin
----------------- ---------------------------------------------
(Date) David G. Martin
Executive Vice President and Chief Financial Officer
(Authorized Officer and Principal Financial and
Accounting Officer of the Registrant)
